Profit from Nasdaq’s “Digestion of Gains”

Just because a stock or an index is choppy and moving sideways doesn’t mean we can’t participate in some profits. There’s opportunity in every situation, especially with options.

In a recent research note sent out to his subscribers, my boy J.C. Parets (@allstarcharts) wrote this about the Nasdaq:

In the Nasdaq Composite, we’re stuck under this overhead supply. That 7600 target was hit this month. A digestion of gains similar to the Dow Jones Averages would be perfectly normal right?

If you agree with JC that the Nasdaq is headed into a period of digestion, then the current volatility environment offers us some nice premium to sell against and gives us plenty of room to be wrong.

Right now, you can sell a pretty wide May Iron Condor (50 days to expiration) with a high statistical chance of earning a profit.

Here’s the play:

Sell the 5920/5925/7100/7125 NDX Iron Condor for approximately $6.75. This trade will require $2500 margin per 1-lot.

If you hold this trade all the way to expiration (not recommended), you’d keep the entire $675 in premium (per one-lot) that you collected at trade initiation if NDX closes below 7100 and above 5925. That’s basically a bet that @allstarcharts is right about “digestion” and we don’t see new all-time highs or a 10% plunge in prices from here before May 25.

However, I wouldn’t encourage you to ride this trade all the way to expiration. We can improve our odds of success by kicking greed to the bench and looking to take profits once we can buy the entire spread back for approximately half of what we sold it for. In this case, I’d leave a resting order to close this spread around $3.30. This is a best practice that if routinely followed with credit spreads like this will yield better results over the long run.

It should be noted, in a worst-case scenario where the markets have an explosive move above or below our breakeven points, the max risk you’d be exposed to is $1825 per one-lot (The $2500 difference between the short and long strike minus the $675 collected at entry). While the odds of this happening are low, they are not insignificant, and therefore be sure to size your position accordingly.